3Q20 Financials Update (Part 2) — Write-Up (11/22/2020)

TFS Financial (TFSL)

This is a small bank in Cleveland that has a few attractive elements to it:

  1. Trades at a ridiculous valuation of book value and earnings
  2. Is a second-step mutual bank — potential to complete the thrift conversion and become even more overcapitalized
  3. Pays a 7% dividend — my punt-on-third down guilty pleasure
  4. Heavily overcapitalized

Earnings were down in the September quarter from $21.5m to $13.5m (-37%). But what really concerns me are the increased costs of borrowed funds in a lower rate environment and the huge one-time gains on loan sales — $11.5m in the quarter and $28.4m for the year. The latter propped up earnings considerably. Without these gains, net income could have been $60m which barely covers the current $0.28 per share dividend.

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I take a little bit of comfort in how overcapitalized this bank is with $1.67bn in equity on $14.5bn in total assets. And with most loans being plain vanilla mortgages — there are unlikely to be many risky loans — as evidenced by the $3m in total provisions for the year ended 9/30/20.

Overcapitalization is obvious here — most banks are shooting for a CET1 ratio in the 10-12% range while TFSL is at ~21-22%! It also helps that the majority of their loans are lower on the risk scale of risk-weighted assets. TFSL probably has $200-300m in excess capital today ($4-6 per share).

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The latest 10-K isn’t yet out so I had to estimate the final quarter in dividends and buybacks but this lays out the basic financial picture…

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The bank has been stable at ~$80m in earnings for years despite lower net interest margins. They spent the 2014-2017 period deploying excess capital into buybacks which has almost completely stopped. Capital allocation has shifted toward dividends lately which suits me just fine — at $17, it’s a 6.5% yield.

With a stable earnings base, I’m not so worried about the dividend as insiders control the company and they have plenty of balance sheet capacity to reduce borrowing costs.

ING Group (ING)

Like other banks, ING has seen some declines in business lately… But this bank has been fairly resilient.

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Back to my original reason for owning this particular bank — it sold off way more than others!

At one point this stock was trading at 0.3x book value vs. historically in the 0.9-1x range. Plenty of other European banks fit this profile but ING has a fairly clean profile with a simple loan book of mostly consumer loans.

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Q3 results saw revenue down, expenses up, and pre-tax earnings down even more. For the year, I see pre-tax earnings before provisions down 15.5% to 5.2bn. There were 310m in goodwill impairments for the year too.

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With a stock price (in EUR) of 7.70 or so and normal earnings looking to be 1-1.10 per share — this is still a cheap stock. Though dividends have been shut off for now, 2019 had a 0.69 per share payout — good for a 9% yield on today’s price.

There are probably some other European banks worth examining at today’s prices…

Parting thoughts…

These positions are mainly just “check ins” for me. My basket of financials were all purchased at statistically low multiples of book value and normalized earnings (when looking through the provisions of 2020). My interpretation is that the stimulus effort and consumer strength will make the provisions quick and mostly painless (if not reversing heavily). The moratorium on share buybacks should end soon and will allow most banks to buyback shares at great prices. Yield curve is steepening again which makes me worry less about interest rates.

My approach to financials isn’t to concentrate in only 1-2 positions (they all seem pretty similar to me at a high level). I’d rather own a handful of good ones and let them all play out equally. An even simpler approach might be to own an ETF but I’d still rather pick and choose my balance sheet quality and capital deployment.